What This Means for

To choose the index that will likely cost you less, note where the index sits today relative to its history and relative to the rate of inflation.

As noted, in 2002 the LIBOR and one-year Treasury indexes had fallen to (or near) their 40-year lows. Plus, both of these indexes fell below the rate of inflation. Given these relationships, one could reasonably conclude that the risk of significant increases greatly exceeded the potential for declines. Without tight caps (see Secret #37) and a short time frame, say less than three years, such a loan didn't offer many advantages. Increases looked far more probable than decreases.

At that time, three- to five-year ARMs were priced at 4.25 to 4.75 percent as opposed to about 6 percent for a 30-year fixed-rate; such loans looked very attractive because you were guaranteed the low rate during that entire introductory period. Again, though, this advice presumes a relatively short-term holding period, and it also presumes that you don't want the assumable fixed-rate mortgage alternative explained in Secret #30.

As to COFI, it also sat so low in 2002 (2.821 percent) that long-term upside moves seemed more likely than further downward drift. In closely comparing rates, ARMs looked especially attractive for the short run but not for periods greater than, say, five years. However, today the mortgage choice favors fixed-rate. The basically flat (and even partially inverted yield curve) makes ARMs look relatively expensive. Nevertheless, if 15- and 30-year fixed-rate loans bounce up to 7.0 to 8.5 percent, while inflation stays at 3.0 percent or less, the relative costs, risks, and benefits could shift back to favor ARMs.

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